The Securities and Exchange Board of India (“SEBI”) on October 18, 2019 vide Circular No. CIR/CFD/CMD1/114/2019 dated October 18, 2019 laid down tighter conditions for the resignation of statutory auditors from listed entities and their material subsidiaries. In July 2019, SEBI had put forth its Consultative paper on policy proposals with respect to resignation of statutory auditors from listed entities. These recommendations were adopted by SEBI’s October 18 circular.
Resignation of an auditor of a listed entity/its material subsidiary before completion of the audit of the financial results for the year due to reasons such as pre-occupation may seriously hamper investor confidence and deny them access to reliable information for taking timely investment decisions. - SEBI
In order to appreciate the significance of this policy move, it is important to understand the role of Auditors and Audit Committee in Corporate Governance as well as events that led us to this Circular.
Corporate Governance
Concept
Corporate Governance is the governance of the company to ensure that it functions in the best interest of all stakeholders. It is aimed to promote fairness, transparency and accountability.[1] Good corporate governance ensures that adequate disclosures and effective decision making are utilized to achieve corporate objectives, that business transactions are transparent, shareholder interest is protected and that the business remained committed to values and ethics.[2] It also aids in a better allocation of capital.
Role of Auditor
The auditor is vested with the obligation of verifying whether the financial information made available to investors and the public is reliable. His purpose is the declaration of expert opinion to avow the fairness with which financial statements present the company’s financial position, results of operations and cash flow in conformity with the Generally Accepted Accounting Practices.[3] In order to do so, his role is to scrutinize the financial statements and supporting records by adopting sound and accepted auditing techniques.[4] While public accounting firms typically offer various services to clients, auditing is different, in that, it involves public responsibility. [5]
Audits are broadly of two types – statutory and internal audits. We are concerned with the former, which is orchestrated so as to announce and communicate with the stakeholders, the state of a company’s finance and accounts per disclosure requirements. Statutory audit norms are prescribed in the Companies Act 2013. It resolves to set the seal on fairness and accuracy of the company's current financial position portrayed by the accounts and balance sheet as on the date. Since shareholders do not directly partake in all day to day management of the company, the accounts offer assurance as to the working of directors and management. Thus it is important that the accounts are maintained and published fairly and accurately. As a result of this requirement, the norms prescribed for an independent/ statutory audit. The statutory auditor has complete authority to verify the financial records of the company and to publish his findings via an auditor’s report.[6]
Notably however, one of the most common bad governance practices is the non-cooperation of companies sufficiently with the auditors and not selecting auditors with appropriate scale, resulting in the publication of spurious or non-compliant financial documents. [7]
Role of Audit Committee
Kotak Committee Report on Corporate Governance (2017) paved the way for setting up of an Audit Committee. Audit Committee is a crucial contributor to effective corporate governance. it is vital in offering effective oversight of performance, independence and objectivity of the auditor and quality of the audit. [8]
The Audit Committee is responsible for overseeing financial reporting and its disclosures. All listed companies are mandated to maintain an audit committee as a prerequisite for listing on the stock exchange.[9] Its role includes the oversight of financial reporting, the monitoring of accounting policies, and the oversight of any external auditors, regulatory compliance and the discussion of risk management policies with the management.[10]
Section 177 lays down that Every Audit Committee work in accordance with the terms of reference specified in writing by the Board per the norms. The Audit Committee is vested with the role of recommending appointment, remuneration and terms of appointment of auditors, review and monitoring the auditor’s independence and performance as well as the effectiveness of audit process; the committee also examines the financial statement and auditor’s report thereon. A more detailed role of the Audit Committee is provided in Schedule II, Part C of the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 ("LODR Regulations"). This includes the responsibility of reviewing with the management, the annual and quarterly financial statements before submitting it to the board ofr approval as also of having a discussion with internal auditor of any significant findings and follow up thereon. Further, the Committee is also responsible for reviewing with the management, the performance of statutory and internal auditors as well as the adequacy of internal control systems.
Policy recommendations and changes
According to data provided by NSE Infobase, the year 2018 saw mid-term cessations of 48 auditors and another 16 so far this year.[11] It had come to SEBI’s notice the commonality in reasoning submitted by most auditors while resigning is that of 'pre-occupation'. To curb this practice, and for protection of investors and other stakeholders, the aforementioned circular floated conditions in two faceted manners based on the consultation paper. First, by strengthening disclosures to investors and second, by strengthening and clarifying the role of the Audit Committee.
Strengthening disclosure to investors
For a listed entity- if the auditor signed the audit report for all quarters (whether limited or audit) of financial year, except the last quarter, then the auditor shall finalize the audit report for the said financial year before resignation. Otherwise, the auditor must issue limited review/audit report for the quarter in which he resigns, before such resignation.
For a material unlisted subsidiary of listed entity- the auditor must issue limited review/audit report for that financial year/quarter as applicable before such resignation (i.e., previous financial year/ quarter in reference to the date of resignation).
If the cause for auditor’s resignation is that the entity was not providing information, the auditor shall provide for an appropriate disclaimer per the accounting standards, in the audit report to that tune.
Reporting concerns
The circular provides that if there is any non-availability of information/non-cooperation by the management which may hamper audit process, the auditor should approach the chairman of the audit committee and the audit committee shall receive such concern directly and immediately without specifically waiting for the quarterly Audit Committee meetings.
In case the auditor proposes to resign, all concerns with respect to the proposed resignation, along with relevant documents shall be brought to the notice of the Audit Committee.
In cases where the proposed resignation is due to non-receipt of information/explanation from the company, the auditor shall inform the Audit Committee of the details of information/explanation sought and not provided by the management, as applicable. On receipt of such information from the auditor relating to the proposal to resign as mentioned above, the Audit Committee/board of directors, as the case may be, shall deliberate on the matter and communicate its views to the management and the auditor
Responsibilities of the resigning auditor
The auditor’s resignation letter would have to provide for detailed reasons and a declaration that there are no other material reasons other than as provided therein. In case he has expressed concern, his efforts prior to resignation (including that of approaching the audit committee). If the auditor cites the reason for resignation as the refusal to make information available to him he must provide details of what information was requested and not provided to him, whether such inability to obtain appropriate audit evidence was due to management imposed limitation or circumstances beyond the control of management.
The auditor must also provide an assessment of the materiality and whether he could have performed alternative procedures to obtain appropriate evidence. He has to affirm whether the matter was communicated to the Audit Committee and whether the lack of information was prevalent in the previous reported financial statements/ results and the basis of issuing the same.
Responsibilities of the listed entity
This resignation letter has to be submitted by the entity to the stock exchange, in case of a material unlisted subsidiary, the subsidiary shall disclose the resignation letter to the listed entity, which will, in turn, disclose the same to the stock exchange.
It was proposed that the views of the Audit committee and the Board of Directors (of the listed entity/ unlisted material subsidiary, as applicable) be required to be submitted to the stock exchanges along with the disclosure of the resignation letter of the auditor in the aforesaid prescribed format.
Strengthening the role of the Audit Committee
The auditor shall approach the chairman of the Audit Committee directly and immediately in case of any concerns with the management such as non-availability of information/ any non-co-operation by the management. The auditor shall not specifically wait for the quarterly meetings to take place in order to raise such concerns.
The auditor shall bring to the Audit committee’s notice, all the concerns the auditor has with respect to such resignation, along with relevant documents. In the case where the resignation is due to non-receipt of information/ explanation from the company, the auditor shall enlighten the Audit Committee of the details of the information/ explanation sought and not provided by the management, as applicable.
The Audit Committee shall deliberate on the matter and communicate its views to the management and the auditor. In communicating its views, the Audit Committee shall ensure that it fulfils its role as specified under the LODR Regulations. The listed entity shall ensure the disclosure of the Audit committee’s views to the Stock exchanges.
Upon the resignation of the auditor, the Audit Committee shall deliberate upon all the concerns raised by the auditor with respect to its resignation as soon as possible, but not later than the date of the next Audit Committee meeting and communicate its views to the management. The listed entity shall ensure the disclosure of the Audit Committee’s views to the stock exchanges as soon as possible but not later than twenty-four hours after the date of such Audit Committee meeting.
A periodic review of auditor’s performance would enable the audit committee better supervision over changes that would not be blatant under the present norms. It would also supplement the effectiveness of the Audit Committee by demonstrating the independence and performance of the audit and auditor.
[2] Ibid.
[9] SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015.